VZCZCXRO0323
RR RUEHLMC
DE RUEHMU #0373/01 0921617
ZNY CCCCC ZZH
R 011617Z APR 08 ZDK
FM AMEMBASSY MANAGUA
TO RUEHC/SECSTATE WASHDC 2349
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE
RUEHCV/AMEMBASSY CARACAS 1248
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHDC
RHEHNSC/NSC WASHINGTON DC

C O N F I D E N T I A L SECTION 01 OF 03 MANAGUA 000373 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/AND, WHA/EPSC, AND EEB/OMA 
USDOC FOR 4332/ITA/MAC/WH/MSIEGELMAN 
3134/ITA/USFCS/OIO/WH/MKESHISHIAN/BARTHUR 
 
E.O. 12958: DECL: 03/31/2018 
TAGS: ECON EFIN ENRG EPET EAID PGOV PREL NU
SUBJECT: NICARAGUA: IMF SIX MONTH REVIEW 
 
REF: A. 07 MANAGUA 2524 
     ¶B. 07 MANAGUA 1771 
     ¶C. 07 MANAGUA 2373 
     ¶D. 07 MANAGUA 2185 
 
Classified By: DCM Richard M. Sanders for reasons 1.4 b & d. 
 
¶1. (C) Summary:  On March 7 a visiting IMF review team stated 
that Nicaragua had performed satisfactorily during the first 
six months of its Poverty Reduction and Growth Facility 
(PRGF).  Nicaragua met most quantitative and structural 
targets.  General IMF recommendations emphasized improving 
the investment climate and Nicaraguan competitiveness and 
increasing capital and anti-poverty expenditures.  The IMF 
team remains concerned about Nicaragua's rising inflation and 
the lack of transparency surrounding assistance from 
Venezuela.  Both of these issues were on the agenda for the 
week of follow-up meeting scheduled for March 25.  While on 
the surface things are progressing well in the IMF-GON 
relationship, tensions remain regarding the government's 
commitment to the PRGF.  End Summary. 
 
Overview on PRGF Performance and Next Steps 
------------------------------------------- 

¶2. (SBU) At the end of its two week mission (February 
25-March 7) the IMF review team, under the direction of new 
team leader Luis Cubeddu, stated that Nicaragua had performed 
satisfactorily during the first six months of its PRGF, 
noting considerable progress on the implementation of the 
overall economic program.  Reserves, fiscal expenditures, and 
the budget deficit fell within reasonable margins.  However, 
Nicaragua did not meet its targets for real GDP growth, 
inflation, and the minimum for social spending (Ref B).  The 
IMF team stated that the 2008 National Budget is consistent 
with the parameters of the program.  Nicaragua met all of the 
structural targets, with the exception of the electricity 
theft law, which was only passed in general terms in the 
National Assembly during the visit. 
 
¶3. (SBU) 2007 targets and results and 2008 revised targets 
are as follows: 
 
2007                      Target (Ref B)          Result 
--------------------------------------------- ----------- 
Real GDP growth rate        4.2%                   3.8% 
Inflation                   7.5%                  16.8% 
Deficit (as % of GDP)       1.0%                   1.0% 
Increase in Reserves (USD) 60 million         160 million 
GDP (USD)                   5 billion         5.7 billion 
 
2008                     Target  (Ref B)    Revised Target 
--------------------------------------------- ------------- 
Real GDP growth rate        4.5%                    4.0% 
Inflation                   7.0%                   10.0% 
Deficit (as % of GDP)       1.8%                    1.8% 
Increase in Reserves (USD) 70 million            70 million 
GDP (USD)                                       6.4 billion 
 
¶4. (SBU) IMF recommendations emphasized improving the 
investment climate and Nicaraguan competitiveness, increasing 
capital and anti-poverty expenditures, and hiring a 
consultant to create a national development plan.  Nicaragua 
has requested an overall revision of program parameters given 
that the IMF calculated the original PRGF with oil at USD 76 
per barrel.  The IMF, World Bank (WB), and Inter-American 
Development Bank (IDB) will continue to work together to help 
the GON improve financial/fiscal transparency.  Pending 
issues, to have been discussed in Washington meetings the 
week of March 25, include an anti-inflation program, salary 
policy, and the renegotiation of local bank bonds (CENIs). 
The IMF ResRep told us the IMF plans to propose tax reform be 
part of the next review in six months. 
 
¶5. (U) The IMF Board will vote on the semi-annual review and 
revised PRGF targets at the end of April.  Provided the Board 
approves the review, the IMF will disburse USD 16 million. 
Nicaragua already received one disbursement of USD 18.5 
million in 2007, as part of the three-year USD 110 million 
program. 
 
A Message to Donors 
------------------- 

¶6. (C) The IMF team expressed concern to the Budget Support 
Group donors (BSG), who will provide USD 100 million in 
direct budget support in 2008, regarding the delay in 
disbursement of funds.  Most donors planned on third and 
fourth quarter disbursements; dependent on the results of 
their semi-annual review of the GON's performance.  The IMF 
team believes that the delayed disbursements limit the GON's 
ability to engage in financial planning and effective fiscal 
management.  According to the IMF, if Venezuela fills the 
financing gap, donors will find they have lost influence with 
the GON.  The IDB and WB offered to look at moving up their 
disbursement schedules. 
 
Inflation is the Central Issue 
------------------------------ 

¶7. (C) The principal item on the agenda is the steep increase 
in Nicaragua's inflation; over twice the PRGF target for 
¶2007.  The IMF team agrees with GON analysis that the 
principal causes were the supply shocks of world oil prices, 
high international food commodity prices, and the rise in 
domestic food prices due to the Pacific coast floods (Ref A). 
 However, the IMF calculated that starting in November 2007, 
core inflation (excluding food and energy) rose 8%, 
indicating that there are demand components to this 
inflation.  This problem continues as annualized core 
inflation in January was 11.6% and rose to 13% in February. 
(Note: Post will report more fully on Nicaragua's inflation 
septel. End Note.) 
 
¶8. (C) The IMF strongly recommends the GON immediately 
implement an anti-inflation program which combines monetary, 
fiscal and salary policies that can reduce inflation back to 
the 8-10% range.  Key elements will be for the GON to manage 
expectations, control demand, and establish a clear salary 
policy which limits further increases. 
 
¶9. (C) The Nicaraguan Central Bank (BCN) promised it would 
announce an anti-inflation program as part of an overall 
anti-corruption program; however, the IMF is not optimistic 
that a program will take place soon.  (Note: The BCN did not 
clarify how they would relate inflation to anti-corruption. 
End note.)  In fact, policy decisions in the last 12 months 
have been expansionary: a 33% increase in the minimum wage 
and a 14% salary increase for government employees in the 
2008 budget.  Also worrisome is the GON's stated desire to 
take full advantage of the PRGF allowance for an increase in 
the deficit by 2% of GDP for social spending using Venezuelan 
assistance funds. 
 
Venezuela Assistance: What, Where, and How ) For Now 
--------------------------------------------- ------- 

¶10. (C) One of the largest unknown factors in any discussion 
of Nicaragua's economy and its inflation is Venezuelan 
assistance.  The PRGF assumed that the GON would funnel most 
of the funds through the public sector.  The IMF's review of 
the books of the companies handling the funds, facilitated by 
the GON, revealed that the GON is actually processing the 
funds through private and quasi-private companies.  The IMF 
estimates that Venezuelan assistance (in cash and in-kind) in 
2007 was USD 202 million or 3.5% of GDP.  Of this, the oil 
import scheme represented USD 91 million or 1.6% of GDP.  The 
estimates for 2008 are total assistance of USD 515 million, 
or 8% of GDP.  Income from the oil import scheme will be USD 
279 million, or 4.4% of GDP.  From what the IMF was able to 
determine, in 2007 the Venezuelan assistance included items 
such as subsidized fuel for state owned electricity 
generating plants, hurricane relief, subsidies for public 
transportation, and grants to the Ministry of Health and the 
Army, among others.  Use of 2008 funds remains unclear, 
however, complicating the IMF's ability to determine whether 
the Nicaraguan economy can absorb these funds effectively. 
To capture more data about Venezuelan assistance, the IMF 
plans to ask for semi-annual reports on donor assistance, 
including assistance to the private sector. 
 
¶11. (C) Most worrisome for IMF ResRep Humberto Arbulu Neira 
is that no one in the GON seems to have a clear grasp of the 
scope of what Venezuela is doing in Nicaragua.  He told the 
Ambassador on March 17 that when the IMF team presented its 
data to high ranking GON members, the response was "That is 
wrong.  That is too much."  When asked for the GON's 
consolidated figures on Venezuelan assistance, no one could 
provide them.  Arbulu is also puzzled by the complete 
disregard on part of the Minister of Finance for the 
potential role these financial inflows are having on 
Nicaragua's economy and inflation.  The Minister told Arbulu, 
"It is not my concern.  Show me the economic model which 
demonstrates that assistance can have inflationary and 
distorting effects." 
 
¶12. (C) During a March 4 conversation with WHA/CEN Director 
Feeley, BCN President Antenor Rosales was also unconcerned 
about the effects of Venezuelan assistance, as long as it 
finances production, particularly agricultural production. 
According to Rosales, he has successfully argued to President 
Ortega that Venezuelan assistance could not be in the form of 
new loans as it would risk the terms of Nicaragua's benefits 
under HIPC.  He concluded the discussion by admitting that 
the issue is "very political;" a tacit acknowledgment that 
inflationary effects of Venezuelan assistance may take a back 
seat to Ortega-Chavez political goals. 
 
Pending Issue in Energy Sector 
------------------------------ 

¶13. (SBU) The PRGF laid out two main energy objectives in 
2007/2008, passage of an electricity theft law and a 
technical audit of electricity distributor Union Fenosa. 
Colombian consulting firm ConCol will complete the audit of 
Spanish-owned Union Fenosa's infrastructure investments and 
technical losses in July.  The National Assembly passed the 
electricity theft law "in principle" on March 12, after the 
IMF tied its passage to further disbursement of funds to the 
GON.  Starting on March 27, the National Assembly began to 
review and approve the bill article by article.  The bill has 
been controversial because leftist legislators see it as 
favoring Union Fenosa at the cost of the consumers.  The bill 
lays out fines (up to 1,000 times the minimum wage) and jail 
time (six months to five years) for electricity theft and 
fraud and focuses on consumers of more than 500 KW a month. 
Implementing the law will remain a challenge as it depends 
upon the publication of Nicaragua's new Penal Code.  The 
Ortega government has held up formally publishing the new 
Penal Code for political reasons, although it claims it is a 
lack of money (Ref C). 
 
Domestic Debt Also an Area of Concern 
------------------------------------- 

¶14. (C) The IMF team is concerned that Nicaragua's overall 
debt profile remains high because of its excessive domestic 
debt load.  In 2007 Nicaragua's internal debt was USD 1.1 
billion, 19.7% of GDP (Ref C).  Two-thirds of the domestic 
debt is bonds issued to compensate property owners, including 
U.S. citizens, who had their property confiscated in the 
1980s.  Most of the remainder are bank bonds, bonds issued to 
refinance the CENIs bonds originally issued to bail out four 
collapsing banks between 1999-2001.  The bank bonds represent 
less than 25% of domestic debt load and servicing in 2007 
totaled 0.5% of GDP.  Because the bank bonds are politically 
unpopular (Ref D), however, they have been the GON's chosen 
target for refinancing.  The political frenzy surrounding the 
bonds has led to the offices of the Attorney General and 
Comptroller General (equivalent to the GAO) to join the 
Ministry of Finance and BCN in negotiating with the banks 
holding the bonds.  The IMF team is very concerned that the 
banks have not had a choice on the refinancing and has 
emphasized to the GON that the final agreement must be 
negotiated in a transparent and voluntary fashion.  The IMF 
is also trying to dissuade the GON from using the money saved 
from the refinancing to increase salaries for state 
employees; suggesting they be added to reserves instead. 
 
Comment 
------- 

¶15. (C) While on the surface things are progressing well in 
the IMF-GON relationship, tensions remain regarding the 
government's commitment to the PRGF.  Many donors, including 
the IMF, are concerned that Ortega is only interested in the 
PRGF as a tool to keep donors in country.  He, and many of 
his closest economic advisors, believe that the PRGF 
objectives of economic stability are subordinate to political 
goals.  As long as the PRGF serves the GON's political 
objectives, the GON will take the actions required to abide 
by the terms of the agreement.  If it becomes politically 
necessary, however, the GON will quickly drop the program. 
TRIVELLI